As the market for U.S. office, retail and apartment building loans heads south, investors in commercial mortgage-backed securities and servicers of the loans are feuding over how to best save their skins.

Big bondholders including BlackRock Inc and MetLife Inc are collaborating to fend off changes in tax law sought by servicing companies to lessen the impact of the credit crunch on the property values, which are plunging.

Servicing companies are lobbying the U.S. Treasury for a revision in tax rules that would let buyers of foreclosed properties take on existing loans, greasing the transaction, according to investors. But the holders of top-rated CMBS are balking at extensions of underlying loans after foreclosure, saying they amount to a subsidy and would hurt returns over normal liquidation procedures.

The proposal by servicers reflects a desperate market, with needy borrowers faced with a market dormant since early 2008. The lack of funding has all but eliminated viable refinancing options, and was a big factor in sending delinquencies of loans in CMBS near record highs at 1.85 percent last quarter, according to Standard & Poor's.

Federal Reserve officials have also focused on ailing commercial real estate as a key source of stress at the nation's financial institutions, whose clogged balance sheets are keeping the banks from freeing up credit for the industry and exacerbating the U.S. recession.

Bondholders know buyers are rare, and aren't totally opposed to servicer efforts. They would allow financings for buyers under certain terms, such as capping maturities and forcing borrowers to hold a minimum of 25 percent equity.

With commercial real estate prices off more than 20 percent from a year ago, borrower equity is vanishing.

We can support the idea as long as the proposal has constraints, said one investor, who because of negotiations asked for anonymity. We don't want the new loans to be made just to subsidize property sales and have new loans default again, which is entirely possible.

Both sides are keenly interested in a solution to the liquidity crunch given the daunting numbers of loans that must be refinanced. Loans in CMBS maturing this year total $15 billion, and will rise to $42 billion in 2010 and $69 billion in 2011, according to Credit Suisse.

The balance of commercial real estate mortgages transferred to troubled loan specialists soared 48 percent last quarter to $23.7 billion, and will spike again due to the bankruptcy of the No. 2 U.S. mall owner, General Growth Properties Inc , according to Fitch Ratings.

The groups will meet on Wednesday, but a resolution is not expected, said a source familiar with negotiations mediated by the Commercial Mortgage Securities Association.

The row has parallels with travails in the residential mortgage bond market, where Blackrock and other bondholders including Fortress Investment Group are protesting their treatment in federal policies to stabilize housing. Incentive payments to home loan servicers, and a proposal to protect the companies from bondholder challenges would give them too much leeway to modify mortgages at investor expense, the investor group contends.

In the CMBS dispute, middle ground has been elusive. Investors harbor suspicions of servicers' agendas since many hold the riskiest portion of bonds that could lose big in liquidations but retain some value under their proposal.

Servicers must show that loan extensions or the proposed mortgage assumptions will leave bondholders better off than a foreclosure and distressed sale. Total losses on liquidated loans have surged to 73 percent this year from 34 percent in 2008, according to Credit Suisse.

Investors contend servicers cherry pick data to make their case for a solution that is best for all parties.

It's a serious conflict, said Precilla Torres, a managing director at NewOak Capital LLC in New York. But at same time, the special servicers take very, very seriously their fiduciary responsibility of maximizing present value.

What's more, the rout in mortgage debt has already pummeled the holdings, known as B-pieces, of these servicers, she said.

Servicers know that their analysis has the potential to be scrutinized during a lawsuit, Torres said. They are not going to risk (lawsuits) for a B-piece that is already toast.

One of the largest servicers, Midland Loan Services, is not an investor but still sides with its industry, an investor said. Midland declined to comment.

The urgency of a solution is palpable. Commercial property sales totaled $9.2 billion last quarter, compared with $47.8 billion a year earlier and $133.4 billion for the same period in 2007, according to Real Capital Analytics.

The market is looking very sickly, said Peter Slatin, editorial director at Real Capital Analytics.

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